CINCINNATI FINANCIAL CORP 10-Q

Item 3. Quantitative and Qualitative Disclosures About Market Risk Our greatest exposure to market risk is through our investment portfolio. Market risk is the potential for a decrease in securities' fair value resulting from broad yet uncontrollable forces such as: inflation, economic growth or recession, interest rates, world political conditions or other widespread unpredictable events. It is comprised of many individual risks that, when combined, create a macroeconomic impact. Our view of potential risks and our sensitivity to such risks is discussed in our 2021 Annual Report on Form 10-K, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, Page 112. The fair value of our investment portfolio was $20.574 billion at September 30, 2022, down $3.763 billion from year-end 2021, including a $1.288 billion decrease in the fixed-maturity portfolio and a $2.475 billion decrease in the equity portfolio. (Dollars in millions) At September 30, 2022 At December 31, 2021 Cost or amortized cost Percent of total Fair value Percent of total Cost or amortized cost Percent of total Fair value Percent of total Taxable fixed maturities $ 8,838 51.7 % $ 8,036 39.0 % $ 8,344 51.0 % $ 8,858 36.4 % Tax-exempt fixed maturities 3,974 23.2 3,698 18.0 3,886 23.8 4,164 17.1 Common equities 3,838 22.4 8,433 41.0 3,697 22.6 10,862 44.6 Nonredeemable preferred equities 454 2.7 407 2.0 424 2.6 453 1.9 Total $ 17,104 100.0 % $ 20,574 100.0 % $ 16,351 100.0 % $ 24,337 100.0 % At September 30, 2022, substantially all of our consolidated investment portfolio, measured at fair value, is classified as Level 1 or Level 2. See Item 1, Note 3, Fair Value Measurements, for additional discussion of our valuation techniques. In addition to our investment portfolio, the total investments amount reported in our condensed consolidated balance sheets includes Other invested assets. Other invested assets included $311 million of private equity investments, $38 million in Lloyd's deposits, $35 million of real estate through direct property ownership and development projects in the United States and $30 million of life policy loans at September 30, 2022. Cincinnati Financial Corporation Third-Quarter 2022 10-Q Page 61 FIXED-MATURITY SECURITIES INVESTMENTS By maintaining a well-diversified fixed-maturity portfolio, we attempt to reduce overall risk. We invest new money in the bond market on a regular basis, targeting what we believe to be optimal risk-adjusted, after-tax yields. Risk, in this context, includes interest rate, call, reinvestment rate, credit and liquidity risk. We do not make a concerted effort to alter duration on a portfolio basis in response to anticipated movements in interest rates. By regularly investing in the bond market, we build a broad, diversified portfolio that we believe mitigates the impact of adverse economic factors. In the first nine months of 2022, the decrease in fair value of our fixed-maturity portfolio reflected net purchases of securities, offset by a decrease in net unrealized gains, primarily due to an increase in U.S. Treasury yields and a widening of corporate credit spreads. At September 30, 2022, our fixed-maturity portfolio with an average rating of A3/A was valued at 91.6% of its amortized cost, compared with 106.5% at December 31, 2021. At September 30, 2022, our investment-grade and noninvestment-grade fixed-maturity securities represented 79.6% and 4.5% of the portfolio, respectively. The remaining 15.9% represented fixed-maturity securities that were not rated by Moody's or S&P Global Ratings. Attributes of the fixed-maturity portfolio include: At September 30, 2022 At December 31, 2021 Weighted average yield-to-amortized cost 4.12 % 4.02 % Weighted average maturity 7.4 yrs 8.0 yrs Effective duration 5.0 yrs 4.8 yrs We discuss maturities of our fixed-maturity portfolio in our 2021 Annual Report on Form 10-K, Item 8, Note 2, Investments, Page 134, and in this quarterly report Item 2, Investments Results. Cincinnati Financial Corporation Third-Quarter 2022 10-Q Page 62 TAXABLE FIXED MATURITIES Our taxable fixed-maturity portfolio, with a fair value of $8.036 billion at September 30, 2022, included: (Dollars in millions) At September 30, 2022 At December 31, 2021 Investment-grade corporate $ 6,160 $ 6,807 States, municipalities and political subdivisions 784 931 Noninvestment-grade corporate 519 690 Commercial mortgage-backed 240 273 United States government 188 123 Government-sponsored enterprises 119 8 Foreign government 26 26 Total $ 8,036 $ 8,858 Our strategy is to buy, and typically hold, fixed-maturity investments to maturity, but we monitor credit profiles and fair value movements when determining holding periods for individual securities. With the exception of United States agency issues that include government-sponsored enterprises, no individual issuer's securities accounted for more than 1.2% of the taxable fixed-maturity portfolio at September 30, 2022. Our investment-grade corporate bonds had an average rating of Baa1 by Moody's or BBB by S&P Global Ratings and represented 76.6% of the taxable fixed-maturity portfolio's fair value at September 30, 2022, compared with 76.9% at year-end 2021. The heaviest concentration in our investment-grade corporate bond portfolio, based on fair value at September 30, 2022, was the financial sector. It represented 43.9% of our investment-grade corporate bond portfolio, compared with 41.4% at year-end 2021. The energy sector represented 10.2% and was less than 10% at year-end 2021. No other sector exceeded 10% of our investment-grade corporate bond portfolio. Our taxable fixed-maturity portfolio at September 30, 2022, included $240 million of commercial mortgage-backed securities with an average rating of Aa2/AA-. TAX-EXEMPT FIXED MATURITIES At September 30, 2022, we had $3.698 billion of tax-exempt fixed-maturity securities with an average rating of Aa2/AA by Moody's and S&P Global Ratings. We traditionally have purchased municipal bonds focusing on general obligation and essential services issues, such as water, waste disposal or others. The portfolio is well diversified among approximately 1,700 municipal bond issuers. No single municipal issuer accounted for more than 0.6% of the tax-exempt fixed-maturity portfolio at September 30, 2022. INTEREST RATE SENSITIVITY ANALYSIS Because of our strong surplus, long-term investment horizon and ability to hold most fixed-maturity investments until maturity, we believe the company is adequately positioned if interest rates were to rise. Although the fair values of our existing holdings may suffer, a higher rate environment would provide the opportunity to invest cash flow in higher-yielding securities, while reducing the likelihood of untimely redemptions of currently callable securities. While higher interest rates would be expected to continue to increase the number of fixed-maturity holdings trading below 100% of amortized cost, we believe lower fixed-maturity security values due solely to interest rate changes would not signal a decline in credit quality. We continue to manage the portfolio with an eye toward both meeting current income needs and managing interest rate risk. Our dynamic financial planning model uses analytical tools to assess market risks. As part of this model, the effective duration of the fixed-maturity portfolio is continually monitored by our investment department to evaluate the theoretical impact of interest rate movements. Cincinnati Financial Corporation Third-Quarter 2022 10-Q Page 63 The table below summarizes the effect of hypothetical changes in interest rates on the fair value of the fixed-maturity portfolio: (Dollars in millions) Effect from interest rate change in basis points -200 -100 - 100 200 At September 30, 2022 $ 12,928 $ 12,329 $ 11,734 $ 11,145 $ 10,580 At December 31, 2021 $ 14,327 $ 13,656 $ 13,022 $ 12,399 $ 11,768 The effective duration of the fixed-maturity portfolio as of September 30, 2022, was 5.0 years, up from 4.8 years at year-end 2021. The above table is a theoretical presentation showing that an instantaneous, parallel shift in the yield curve of 100 basis points could produce an approximately 5.0% change in the fair value of the fixed-maturity portfolio. Generally speaking, the higher a bond is rated, the more directly correlated movements in its fair value are to changes in the general level of interest rates, exclusive of call features. The fair values of average- to lower-rated corporate bonds are additionally influenced by the expansion or contraction of credit spreads. In our dynamic financial planning model, the selected interest rate change of 100 to 200 basis points represents our view of a shift in rates that is quite possible over a one-year period. The rates modeled should not be considered a prediction of future events as interest rates may be much more volatile in the future. The analysis is not intended to provide a precise forecast of the effect of changes in rates on our results or financial condition, nor does it take into account any actions that we might take to reduce exposure to such risks. EQUITY INVESTMENTS Our equity investments, with a fair value totaling $8.840 billion at September 30, 2022, included $8.433 billion of common stock securities of companies generally with strong indications of paying and growing their dividends. Other criteria we evaluate include increasing sales and earnings, proven management and a favorable outlook. We believe our equity investment style is an appropriate long-term strategy. While our long-term financial position would be affected by prolonged changes in the market valuation of our investments, we believe our strong surplus position and cash flow provide a cushion against short-term fluctuations in valuation. Continued payment of cash dividends by the issuers of our common equity holdings can provide a floor to their valuation. The table below summarizes the effect of hypothetical changes in market prices on fair value of our equity portfolio. (Dollars in millions) Effect from market price change in percent -30% -20% -10% — 10% 20% 30% At September 30, 2022 $ 6,188 $ 7,072 $ 7,956 $ 8,840 $ 9,724 $ 10,608 $ 11,492 At December 31, 2021 $ 7,921 $ 9,052 $ 10,184 $ 11,315 $ 12,447 $ 13,578 $ 14,710 At September 30, 2022, Apple Inc. (Nasdaq:AAPL) was our largest single common stock holding with a fair value of $638 million, or 7.6% of our publicly traded common stock portfolio and 3.1% of the total investment portfolio. Thirty-five holdings among eight different sectors each had a fair value greater than $100 million. Cincinnati Financial Corporation Third-Quarter 2022 10-Q Page 64 Common Stock Portfolio Industry Sector Distribution Percent of common stock portfolio At September 30, 2022 At December 31, 2021 Cincinnati Financial S&P 500 Industry Weightings Cincinnati Financial S&P 500 Industry Weightings Sector: Information technology 28.4 % 26.4 % 31.1 % 29.2 % Healthcare 15.1 15.1 13.5 13.3 Financial 13.1 11.0 14.2 10.7 Industrials 11.1 7.9 11.1 7.8 Consumer staples 8.1 6.9 6.9 5.9 Consumer discretionary 7.7 11.7 8.3 12.5 Energy 4.7 4.5 4.0 2.7 Materials 4.7 2.5 4.4 2.5 Utilities 3.0 3.1 2.2 2.5 Real estate 2.8 2.8 2.7 2.8 Telecomm services 1.3 8.1 1.6 10.1 Total 100.0 % 100.0 % 100.0 % 100.0 % UNREALIZED INVESTMENT GAINS AND LOSSES At September 30, 2022, unrealized investment gains before taxes for the fixed-maturity portfolio totaled $37 million and unrealized investment losses amounted to $1.115 billion before taxes. The $1.078 billion net unrealized loss position in our fixed-maturity portfolio at September 30, 2022, moved from a net unrealized gain position to a net unrealized loss position in the first nine months of 2022, primarily due to an increase in U.S. Treasury yields and a widening of corporate credit spreads. The net loss position for our current fixed-maturity holdings will naturally decline over time as individual securities approach maturity. In addition, changes in interest rates can cause rapid, significant changes in fair values of fixed-maturity securities and the net loss position, as discussed in Quantitative and Qualitative Disclosures About Market Risk. For federal income tax purposes, taxes on gains from appreciated investments generally are not due until securities are sold. We believe that the appreciated value of equity securities, compared with the cost of securities that is generally used as a tax basis, is a useful measure to help evaluate how fair value can change over time. On this basis, the net unrealized investment gains at September 30, 2022, consisted of a net gain position in our equity portfolio of $4.548 billion. Events or factors such as economic growth or recession can affect the fair value and unrealized investment gains of our equity securities. The five largest holdings in our common stock portfolio were Apple, Microsoft (Nasdaq:MSFT), UnitedHealth Group Inc. (NYSE:UNH), Accenture Co. (NYSE:ACN) and AbbVie Inc. (NYSE:ABBV), which had a combined fair value of $2.069 billion. Unrealized Investment Losses We expect the number of fixed-maturity securities trading below amortized cost to fluctuate as interest rates rise or fall and credit spreads expand or contract due to prevailing economic conditions. Further, amortized costs for some securities are revised through write-downs recognized in prior periods. At September 30, 2022, 4,049 of the 4,495 fixed-maturity securities we owned had fair values below amortized cost, compared with 278 of the 4,329 securities we owned at year-end 2021. The 4,049 holdings with fair values below amortized cost at September 30, 2022, represented 90.7% of the fair value of our fixed-maturity investment portfolio and $1.115 billion in unrealized losses. • 2,508 of the 4,049 holdings had fair value between 90% and 100% of amortized cost at September 30, 2022. These primarily consist of securities whose current valuation is largely the result of interest rate factors. The fair value of these 2,508 securities was $7.335 billion, and they accounted for $287 million in unrealized losses. • 1,423 of the 4,049 fixed-maturity holdings had fair value between 70% and 90% of amortized cost at September 30, 2022. We believe the 1,423 fixed-maturity securities will continue to pay interest and ultimately Cincinnati Financial Corporation Third-Quarter 2022 10-Q Page 65 pay principal upon maturity. The issuers of these 1,423 securities have strong cash flow to service their debt and meet their contractual obligation to make principal payments. The fair value of these securities was $3.132 billion, and they accounted for $742 million in unrealized losses. • 118 of the 4,049 fixed-maturity holdings had fair value below 70% of amortized cost at September 30, 2022. We believe these fixed-maturity securities will continue to pay interest and ultimately pay principal upon maturity. The fair value of these securities was $172 million, and they accounted for $86 million in unrealized losses. The table below reviews fair values and unrealized losses by investment category and by the overall duration of the securities' continuous unrealized loss position. (Dollars in millions) Less than 12 months 12 months or more Total At September 30, 2022 Fair value Unrealized losses Fair value Unrealized losses Fair value Unrealized losses Fixed maturity securities: Corporate $ 5,835 $ 535 $ 376 $ 126 $ 6,211 $ 661 States, municipalities and political subdivisions 3,831 414 48 19 3,879 433 Commercial mortgage-backed 225 11 14 2 239 13 United States government 173 5 12 — 185 5 Government-sponsored enterprises 101 3 3 — 104 3 Foreign government 21 — — — 21 — Total $ 10,186 $ 968 $ 453 $ 147 $ 10,639 $ 1,115 At December 31, 2021 Fixed maturity securities: Corporate $ 861 $ 13 $ 15 $ — $ 876 $ 13 States, municipalities and political subdivisions 105 2 2 1 107 3 Commercial mortgage-backed 10 — 11 — 21 — United States government 48 — — — 48 — Government-sponsored enterprises 7 — — — 7 — Foreign government 16 — — — 16 — Total $ 1,047 $ 15 $ 28 $ 1 $ 1,075 $ 16 At September 30, 2022, applying our invested asset impairment policy, we determined that the total of $1.115 billion, for securities in an unrealized loss position in the table above, was not the result of a credit loss. During the first nine months of 2022, two fixed-maturity securities that were written down to fair value, due to an intention to be sold, and changes in allowance for credit losses were each less than $1 million. During the first nine months of 2021, five securities were written down to fair value due to an intention to be sold, resulting in $1 million of noncash charges, and we had no allowance for credit losses. During the full year of 2021, we wrote down five securities and recorded $1 million in impairment charges. At December 31, 2021, 278 fixed-maturity securities with a total unrealized loss of $16 million were in an unrealized loss position. Of that total, no fixed-maturity securities had fair values below 70% of amortized cost. Cincinnati Financial Corporation Third-Quarter 2022 10-Q Page 66 The following table summarizes the investment portfolio by severity of decline: (Dollars in millions) Number of issues Amortized cost Fair value Gross unrealized gain (loss) Gross investment income At September 30, 2022 Taxable fixed maturities: Fair valued below 70% of amortized cost 44 $ 142 $ 95 $ (47) $ 4 Fair valued at 70% to less than 100% of amortized cost 1,996 8,186 7,396 (790) 240 Fair valued at 100% and above of amortized cost 132 510 545 35 27 Investment income on securities sold in current year — — — — 13 Total 2,172 8,838 8,036 (802) 284 Tax-exempt fixed maturities: Fair valued below 70% of amortized cost 74 116 77 (39) 2 Fair valued at 70% to less than 100% of amortized cost 1,935 3,310 3,071 (239) 74 Fair valued at 100% and above of amortized cost 314 548 550 2 14 Investment income on securities sold in current year — — — — 2 Total 2,323 3,974 3,698 (276) 92 Fixed-maturities summary: Fair valued below 70% of amortized cost 118 258 172 (86) 6 Fair valued at 70% to less than 100% of amortized cost 3,931 11,496 10,467 (1,029) 314 Fair valued at 100% and above of amortized cost 446 1,058 1,095 37 41 Investment income on securities sold in current year — — — — 15 Total 4,495 $ 12,812 $ 11,734 $ (1,078) $ 376 At December 31, 2021 Fixed-maturities summary: Fair valued below 70% of amortized cost — $ — $ — $ — $ — Fair valued at 70% to less than 100% of amortized cost 278 1,091 1,075 (16) 17 Fair valued at 100% and above of amortized cost 4,051 11,139 11,947 808 427 Investment income on securities sold in current year — — — — 33 Total 4,329 $ 12,230 $ 13,022 $ 792 $ 477 See our 2021 Annual Report on Form 10-K, Item 7, Critical Accounting Estimates, Asset Impairment, Page 57.